Exit Risks of Zero Interest Rates, World Trade Restricting Economic Growth, United States Commercial Banks Assets and Liabilities, United States Housing, World Economic Slowdown and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
Executive Summary
I United States Commercial Banks Assets and Liabilities
IA Transmission of Monetary Policy
IB Functions of Banks
IC United States Commercial Banks Assets and Liabilities
ID Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation
II United States Housing
IV Global Inflation
V World Economic Slowdown
VA United States
VB Japan
VC China
VD Euro Area
VE Germany
VF France
VG Italy
VH United Kingdom
VI Valuation of Risk Financial Assets
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
Appendixes
Appendix I The Great Inflation
IIIB Appendix on Safe Haven Currencies
IIIC Appendix on Fiscal Compact
IIID Appendix on European Central Bank Large Scale Lender of Last Resort
IIIG Appendix on Deficit Financing of Growth and the Debt Crisis
IIIGA Monetary Policy with Deficit Financing of Economic Growth
IIIGB Adjustment during the Debt Crisis of the 1980s
III World Financial Turbulence. Financial markets are being shocked by multiple factors including:
(1) World economic slowdown
(2) Slowing growth in China with political development and slowing growth in Japan and world trade
(3) Slow growth propelled by savings/investment reduction in the US with high unemployment/underemployment, falling wages, hiring collapse, contraction of real private fixed investment, decline of wealth of households over the business cycle by 0.9 percent adjusted for inflation while growing 651.8 percent adjusted for inflation from IVQ1945 to IVQ2012 and unsustainable fiscal deficit/debt threatening prosperity that can cause risk premium on Treasury debt with Himalayan interest rate hikes
(4) Outcome of the sovereign debt crisis in Europe.
This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk financial assets during the week. There are various appendixes for convenience of reference of material related to the debt crisis of the euro area. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention and is available in the Appendixes section at the end of the blog comment. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011 and is available in the Appendixes section at the end of the blog comment. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank and is available in the Appendixes section at the end of the blog comment. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union and is available following Subsection IIIA. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis and is available following Subsection IIIA. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil and is available in the Appendixes section at the end of the blog comment.
IIIA Financial Risks. Financial turbulence, attaining unusual magnitude in recent months, characterized the expansion from the global recession since IIIQ2009. Table III-1, updated with every comment in this blog, provides beginning values on Fri Nov 22 and daily values throughout the week ending on Nov 29, 2013 of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Nov 22 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Nov 22, 2013”, first row “USD/EUR 1.3557 -0.4% -0.6 %,” provides the information that the US dollar (USD) depreciated 0.4 percent to USD 1.3557/EUR in the week ending on Fri Nov 22 relative to the exchange rate on Fri Nov 15 and depreciated 0.6 percent relative to Thu Nov 21. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. An important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf). The most important source of financial turbulence is shifting toward increasing interest rates. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.3557/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Nov 22, appreciating to USD 1.3517/EUR on Mon Nov 25, 2013, or by 0.3 percent. The dollar appreciated because fewer dollars, $1.3517, were required on Mon Nov 25 to buy one euro than $1.3557 on Fri Nov 22. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3557/EUR on Nov 22. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Nov 22, to the last business day of the current week, in this case Fri Nov 29, such as depreciation of 0.3 percent to USD 1.3592/EUR by Nov 29. The third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 0.3 percent from the rate of USD 1.3557/EUR on Fri Nov 22 to the rate of USD 1.3592/EUR on Fri Nov 29 {[(1.3592/1.3557) – 1]100 = 0.3%}. The dollar appreciated (denoted by positive sign) by 0.1 percent from the rate of USD 1.3605 on Thu Nov 28 to USD 1.3592/EUR on Fri Nov 29 {[(1.3592/1.3605) -1]100 = -0.1%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets during risk aversion and return to higher yielding risk assets during risk appetite.
Table III-I, Weekly Financial Risk Assets Nov 25 to Nov 29, 2013
| Fri Nov 22 | Mon 25 | Tue 26 | Wed 27 | Thu 28 | Fri 29 |
| USD/ EUR 1.3557 -0.4% -0.6% | 1.3517 0.3% 0.3% | 1.3573 -0.1% -0.4% | 1.3579 -0.2% 0.0% | 1.3605 -0.4% -0.2% | 1.3592 -0.3% 0.1% |
| JPY/ USD 101.26 -1.1% -0.1% | 101.67 -0.4% -0.4% | 101.27 0.0% 0.4% | 102.16 -0.9% -0.9% | 102.31 -1.0% -0.1% | 102.43 1.2% -0.1% |
| CHF/ USD 0.9067 0.9% 0.7% | 0.9118 -0.6% -0.6% | 0.9065 0.0% 0.6% | 0.9076 -0.1% -0.1% | 0.9055 0.1% 0.2% | 0.9062 0.1% -0.1% |
| CHF/ EUR 1.2294 0.4% 0.2% | 1.2326 -0.3% -0.3% | 1.2304 -0.1% 0.2% | 1.2324 -0.2% -0.2% | 1.2320 -0.2% 0.0% | 1.2316 -0.2% 0.0% |
| USD/ AUD 0.9170 1.0905 -2.2% -0.7% | 0.9161 1.0916 -0.1% -0.1% | 0.9126 1.0958 -0.5% -0.4% | 0.9079 1.1014 -1.0% -0.5% | 0.9102 1.0987 -0.8% 0.2% | 0.9110 1.0977 -0.7% 0.1% |
| 10Y Note 2.746 | 2.734 | 2.71 | 2.736 | 2.736 | 2.743 |
| 2Y Note 0.280 | 0.280 | 0.29 | 0.287 | 0.287 | 0.283 |
| German Bond 2Y 0.13 10Y 1.74 | 2Y 0.13 10Y 1.72 | 2Y 0.12 10Y 1.69 | 2Y 0.13 10Y 1.71 | 2Y 0.12 10Y 1.69 | 2Y 0.11 10Y 1.69 |
| DJIA 16064.77 0.6% 0.3% | 16072.54 0.0% 0.0% | 16072.80 0.0% 0.0% | 16097.33 0.2% 0.2% | 16097.33 0.2% 0.0% | 16086.41 0.1% -0.1% |
| Dow Global 2440.33 0.5% 0.5% | 2444.88 0.2% 0.2% | 2439.07 -0.1% -0.2% | 2442.94 0.1% 0.2% | 2442,94 0.1% 0.0% | 2452.23 0.5% 0.4% |
| DJ Asia Pacific 1443.19 -0.4% 0.1% | 1447.87 0.3% 0.3% | 1446.82 0.2% -0.1% | 1440.49 -0.2% -0.4% | 1440.49 -0.2% 0.0% | 1450.81 0.5% 0.7% |
| Nikkei 15381.72 1.4% 0.1% | 15619.13 1.5% 1.5% | 15515.24 0.9% -0.7% | 15449.63 0.4% -0.4% | 15727.12 2.2% 1.8% | 15661.87 1.8% -0.4% |
| Shanghai 2196.38 2.8% -0.4% | 2186.12 -0.5% -0.5% | 2183.07 -0.6% -0.1% | 2201.07 0.2% 0.8% | 2219.37 1.0% 0.8% | 2220.50 1.1% 0.1% |
| DAX 9219.04 0.5% 0.2% | 9299.95 0.9% 0.9% | 9290.07 0.8% -0.1% | 9351.13 1.4% 0.7% | 9387.37 1.8% 0.4% | 9405.30 2.0% 0.2% |
| DJ UBS Comm. 123.81 0.5% 0.4% | 123.89 0.1% 0.1% | 123.83 0.0% 0.0% | 123.55 -0.2% -0.2% | 123.55 -0.2% 0.0% | 124.21 0.3% 0.5% |
| WTI $/B 94.84 1.3% -0.4% | 94.19 -0.7% -0.7% | 93.68 -1.2% -0.5% | 92.27 -2.7% -1.5% | 92.25 -2.7% 0.0% | 92.72 -2.2% 0.5% |
| Brent $/B 111.05 2.3% 0.8% | 110.88 -0.2% -0.2% | 111.02 0.0% 0.1% | 111.50 0.4% 0.4% | 110.86 -0.2% -0.6% | 109.69 -1.2% -1.1% |
| Gold $/OZ 1244.6 -3.4% 0.2% | 1252.70 0.7% 0.7% | 1242.5 -0.2% -0.8% | 1237.7 -0.6% -0.4% | 1244.50 0.0% 0.5% | 1250.4 0.5% 0.5% |
Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss
Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce
Sources: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
There is initial discussion of current and recent risk-determining events followed below by analysis of risk-measuring yields of the US and Germany and the USD/EUR rate.
First, risk determining events. Prior risk determining events are in an appendix below following Table III-1A. Current focus is on “tapering” quantitative easing by the Federal Open Market Committee (FOMC). At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:
“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.
For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”
There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “tapering” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight. What really matters in the statement of the Federal Open Market Committee (FOMC) on Oct 30, 2013, is interest rates of fed funds at 0 to ¼ percent for the foreseeable future, even with paring of purchases of longer term bonds for the portfolio of the Fed (http://www.federalreserve.gov/newsevents/press/monetary/20131030a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent” (emphasis added).
Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differfrom each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (10
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:
“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).
The President of the European Central Bank (ECB) Mario Draghi explained the indefinite period of low policy rates during the press conference following the meeting on Jul 4, 2013 (http://www.ecb.int/press/pressconf/2013/html/is130704.en.html):
“Yes, that is why I said you haven’t listened carefully. The Governing Council has taken the unprecedented step of giving forward guidance in a rather more specific way than it ever has done in the past. In my statement, I said “The Governing Council expects the key…” – i.e. all interest rates – “…ECB interest rates to remain at present or lower levels for an extended period of time.” It is the first time that the Governing Council has said something like this. And, by the way, what Mark Carney [Governor of the Bank of England] said in London is just a coincidence.”
The European Central Bank (ECB) lowered the policy rates on Nov 7, 2013 (http://www.ecb.europa.eu/press/pr/date/2013/html/pr131107.en.html):
“PRESS RELEASE
7 November 2013 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.25%, starting from the operation to be settled on 13 November 2013.
- The interest rate on the marginal lending facility will be decreased by 25 basis points to 0.75%, with effect from 13 November 2013.
- The interest rate on the deposit facility will remain unchanged at 0.00%.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”
Mario Draghi, President of the ECB, explained as follows (http://www.ecb.europa.eu/press/pressconf/2013/html/is131107.en.html):
“Based on our regular economic and monetary analyses, we decided to lower the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 0.25% and the rate on the marginal lending facility by 25 basis points to 0.75%. The rate on the deposit facility will remain unchanged at 0.00%. These decisions are in line with our forward guidance of July 2013, given the latest indications of further diminishing underlying price pressures in the euro area over the medium term, starting from currently low annual inflation rates of below 1%. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Such a constellation suggests that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. Accordingly, our monetary policy stance will remain accommodative for as long as necessary. It will thereby also continue to assist the gradual economic recovery as reflected in confidence indicators up to October.”
The ECB decision together with the employment situation report on Fri Nov 8, 2013, influenced revaluation of the dollar. Market expectations were of relatively easier monetary policy in the euro area.
The statement of the meeting of the Monetary Policy Committee of the Bank of England on Jul 4, 2013, may be leading toward the same forward guidance (http://www.bankofengland.co.uk/publications/Pages/news/2013/007.aspx):
“At its meeting today, the Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report. The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”
A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 16,086.41
on Fri Nov 29, 2013, which is higher by 13.6 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 13.3 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.
Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exit from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.
Second, Risk-Measuring Yields and Exchange Rate. The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, 2012, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, 2012, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10, 2012 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24, 2012. The yield of the ten-year sovereign bond of Spain traded at 4.123 percent on Nov 29, 2013, and that of the ten-year sovereign bond of Italy at 4.047 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. In the week of Nov 29, 2013, the yield of the two-year Treasury decreased to 0.280 percent and that of the ten-year Treasury decreased to 2.743 percent while the two-year bond of Germany decreased to 0.11 percent and the ten-year decreased to 1.69 percent; and the dollar depreciated to USD 1.3592/EUR. The zero interest rates for the monetary policy rate of the US, or fed funds rate, induce carry trades that ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield of 2.750 percent is higher than consumer price inflation of 1.0 percent in the 12 months ending in Oct 2013 (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html) and the expectation of higher inflation if risk aversion diminishes. The one-year Treasury yield of 0.117 percent (http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3002) is well below the 12-month consumer price inflation of 1.0 percent. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 11/29/13 | 0.283 | 2.743 | 0.11 | 1.69 | 1.3592 |
| 11/22/13 | 0.280 | 2.746 | 0.13 | 1.74 | 1.3557 |
| 11/15/13 | 0.292 | 2.704 | 0.10 | 1.70 | 1.3497 |
| 11/8/13 | 0.316 | 2.750 | 0.10 | 1.76 | 1.3369 |
| 11/1/13 | 0.311 | 2.622 | 0.11 | 1.69 | 1.3488 |
| 10/25/13 | 0.305 | 2.507 | 0.18 | 1.75 | 1.3804 |
| 10/18/13 | 0.321 | 2.588 | 0.17 | 1.83 | 1.3686 |
| 10/11/13 | 0.344 | 2.688 | 0.18 | 1.86 | 1.3543 |
| 10/4/13 | 0.335 | 2.645 | 0.17 | 1.84 | 1.3557 |
| 9/27/13 | 0.335 | 2.626 | 0.16 | 1.78 | 1.3523 |
| 9/20/13 | 0.333 | 2.734 | 0.21 | 1.94 | 1.3526 |
| 9/13/13 | 0.433 | 2.890 | 0.22 | 1.97 | 1.3297 |
| 9/6/13 | 0.461 | 2.941 | 0.26 | 1.95 | 1.3179 |
| 8/23/13 | 0.401 | 2.784 | 0.23 | 1.85 | 1.3221 |
| 8/23/13 | 0.374 | 2.818 | 0.28 | 1.93 | 1.3380 |
| 8/16/13 | 0.341 | 2.829 | 0.22 | 1.88 | 1.3328 |
| 8/9/13 | 0.30 | 2.579 | 0.16 | 1.68 | 1.3342 |
| 8/2/13 | 0.299 | 2.597 | 0.15 | 1.65 | 1.3281 |
| 7/26/13 | 0.315 | 2.565 | 0.15 | 1.66 | 1.3279 |
| 7/19/13 | 0.300 | 2.480 | 0.08 | 1.52 | 1.3141 |
| 7/12/13 | 0.345 | 2.585 | 0.10 | 1.56 | 1.3068 |
| 7/5/13 | 0.397 | 2.734 | 0.11 | 1.72 | 1.2832 |
| 6/28/13 | 0.357 | 2.486 | 0.19 | 1.73 | 1.3010 |
| 6/21/13 | 0.366 | 2.542 | 0.26 | 1.72 | 1.3122 |
| 6/14/13 | 0.276 | 2.125 | 0.12 | 1.51 | 1.3345 |
| 6/7/13 | 0.304 | 2.174 | 0.18 | 1.54 | 1.3219 |
| 5/31/13 | 0.299 | 2.132 | 0.06 | 1.50 | 1.2996 |
| 5/24/13 | 0.249 | 2.009 | 0.00 | 1.43 | 1.2932 |
| 5/17/13 | 0.248 | 1.952 | -0.03 | 1.32 | 1.2837 |
| 5/10/13 | 0.239 | 1.896 | 0.05 | 1.38 | 1.2992 |
| 5/3/13 | 0.22 | 1.742 | 0.00 | 1.24 | 1.3115 |
| 4/26/13 | 0.209 | 1.663 | 0.00 | 1.21 | 1.3028 |
| 4/19/13 | 0.232 | 1.702 | 0.02 | 1.25 | 1.3052 |
| 4/12/13 | 0.228 | 1.719 | 0.02 | 1.26 | 1.3111 |
| 4/5/13 | 0.228 | 1.706 | 0.01 | 1.21 | 1.2995 |
| 3/29/13 | 0.244 | 1.847 | -0.02 | 1.29 | 1.2818 |
| 3/22/13 | 0.242 | 1.931 | 0.03 | 1.38 | 1.2988 |
| 3/15/13 | 0.246 | 1.992 | 0.05 | 1.46 | 1.3076 |
| 3/8/13 | 0.256 | 2.056 | 0.09 | 1.53 | 1.3003 |
| 3/1/13 | 0.236 | 1.842 | 0.03 | 1.41 | 1.3020 |
| 2/22/13 | 0.252 | 1.967 | 0.13 | 1.57 | 1.3190 |
| 2/15/13 | 0.268 | 2.007 | 0.19 | 1.65 | 1.3362 |
| 2/8/13 | 0.252 | 1.949 | 0.18 | 1.61 | 1.3365 |
| 2/1/13 | 0.26 | 2.024 | 0.25 | 1.67 | 1.3642 |
| 1/25/13 | 0.278 | 1.947 | 0.26 | 1.64 | 1.3459 |
| 1/18/13 | 0.252 | 1.84 | 0.18 | 1.56 | 1.3321 |
| 1/11/13 | 0.247 | 1.862 | 0.13 | 1.58 | 1.3343 |
| 1/4/13 | 0.262 | 1.898 | 0.08 | 1.54 | 1.3069 |
| 12/28/12 | 0.252 | 1.699 | -0.01 | 1.31 | 1.3218 |
| 12/21/12 | 0.272 | 1.77 | -0.01 | 1.38 | 1.3189 |
| 12/14/12 | 0.232 | 1.704 | -0.04 | 1.35 | 1.3162 |
| 12/7/12 | 0.256 | 1.625 | -0.08 | 1.30 | 1.2926 |
| 11/30/12 | 0.248 | 1.612 | 0.01 | 1.39 | 1.2987 |
| 11/23/12 | 0.273 | 1.691 | 0.00 | 1.44 | 1.2975 |
| 11/16/12 | 0.24 | 1.584 | -0.03 | 1.33 | 1.2743 |
| 11/9/12 | 0.256 | 1.614 | -0.03 | 1.35 | 1.2711 |
| 11/2/12 | 0.274 | 1.715 | 0.01 | 1.45 | 1.2838 |
| 10/26/12 | 0.299 | 1.748 | 0.05 | 1.54 | 1.2942 |
| 10/19/12 | 0.296 | 1.766 | 0.11 | 1.59 | 1.3023 |
| 10/12/12 | 0.264 | 1.663 | 0.04 | 1.45 | 1.2953 |
| 10/5/12 | 0.26 | 1.737 | 0.06 | 1.52 | 1.3036 |
| 9/28/12 | 0.236 | 1.631 | 0.02 | 1.44 | 1.2859 |
| 9/21/12 | 0.26 | 1.753 | 0.04 | 1.60 | 1.2981 |
| 9/14/12 | 0.252 | 1.863 | 0.10 | 1.71 | 1.3130 |
| 9/7/12 | 0.252 | 1.668 | 0.03 | 1.52 | 1.2816 |
| 8/31/12 | 0.225 | 1.543 | -0.03 | 1.33 | 1.2575 |
| 8/24/12 | 0.266 | 1.684 | -0.01 | 1.35 | 1.2512 |
| 8/17/12 | 0.288 | 1.814 | -0.04 | 1.50 | 1.2335 |
| 8/10/12 | 0.267 | 1.658 | -0.07 | 1.38 | 1.2290 |
| 8/3/12 | 0.242 | 1.569 | -0.02 | 1.42 | 1.2387 |
| 7/27/12 | 0.244 | 1.544 | -0.03 | 1.40 | 1.2320 |
| 7/20/12 | 0.207 | 1.459 | -0.07 | 1.17 | 1.2158 |
| 7/13/12 | 0.24 | 1.49 | -0.04 | 1.26 | 1.2248 |
| 7/6/12 | 0.272 | 1.548 | -0.01 | 1.33 | 1.2288 |
| 6/29/12 | 0.305 | 1.648 | 0.12 | 1.58 | 1.2661 |
| 6/22/12 | 0.309 | 1.676 | 0.14 | 1.58 | 1.2570 |
| 6/15/12 | 0.272 | 1.584 | 0.07 | 1.44 | 1.2640 |
| 6/8/12 | 0.268 | 1.635 | 0.04 | 1.33 | 1.2517 |
| 6/1/12 | 0.248 | 1.454 | 0.01 | 1.17 | 1.2435 |
| 5/25/12 | 0.291 | 1.738 | 0.05 | 1.37 | 1.2518 |
| 5/18/12 | 0.292 | 1.714 | 0.05 | 1.43 | 1.2780 |
| 5/11/12 | 0.248 | 1.845 | 0.09 | 1.52 | 1.2917 |
| 5/4/12 | 0.256 | 1.876 | 0.08 | 1.58 | 1.3084 |
| 4/6/12 | 0.31 | 2.058 | 0.14 | 1.74 | 1.3096 |
| 3/30/12 | 0.335 | 2.214 | 0.21 | 1.79 | 1.3340 |
| 3/2/12 | 0.29 | 1.977 | 0.16 | 1.80 | 1.3190 |
| 2/24/12 | 0.307 | 1.977 | 0.24 | 1.88 | 1.3449 |
| 1/6/12 | 0.256 | 1.957 | 0.17 | 1.85 | 1.2720 |
| 12/30/11 | 0.239 | 1.871 | 0.14 | 1.83 | 1.2944 |
| 8/26/11 | 0.20 | 2.202 | 0.65 | 2.16 | 1.450 |
| 8/19/11 | 0.192 | 2.066 | 0.65 | 2.11 | 1.4390 |
| 6/7/10 | 0.74 | 3.17 | 0.49 | 2.56 | 1.192 |
| 3/5/09 | 0.89 | 2.83 | 1.19 | 3.01 | 1.254 |
| 12/17/08 | 0.73 | 2.20 | 1.94 | 3.00 | 1.442 |
| 10/27/08 | 1.57 | 3.79 | 2.61 | 3.76 | 1.246 |
| 7/14/08 | 2.47 | 3.88 | 4.38 | 4.40 | 1.5914 |
| 6/26/03 | 1.41 | 3.55 | NA | 3.62 | 1.1423 |
Note: DE: Germany
Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
http://www.bloomberg.com/markets/
Appendix: Prior Risk Determining Events. Current risk analysis concentrates on deciphering what the Federal Open Market Committee (FOMC) may decide on quantitative easing. The week of May 24 was dominated by the testimony of Chairman Bernanke to the Joint Economic Committee of the US Congress on May 22, 2013 (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm), followed by questions and answers and the release on May 22, 2013 of the minutes of the meeting of the Federal Open Market Committee (FOMC) from Apr 30 to May 1, 2013 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm). Monetary policy emphasizes communication of policy intentions to avoid that expectations reverse outcomes in reality (Kydland and Prescott 1977). Jon Hilsenrath, writing on “In bid for clarity, Fed delivers opacity,” on May 23, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath), analyzes discrepancies in communication by the Fed. The annotated chart of values of the Dow Jones Industrial Average (DJIA) during trading on May 23, 2013 provided by Hinselrath, links the prepared testimony of Chairman Bernanke at 10:AM, following questions and answers and the release of the minutes of the FOMC at 2PM. Financial markets strengthened between 10 and 10:30AM on May 23, 2013, perhaps because of the statement by Chairman Bernanke in prepared testimony (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm):
“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.”
In that testimony, Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm) also analyzes current weakness of labor markets:
“Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers' skills and--particularly relevant during this commencement season--by preventing many young people from gaining workplace skills and experience in the first place. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.”
Hilsenrath (op. cit. http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath) analyzes the subsequent decline of the market from 10:30AM to 10:40AM as Chairman Bernanke responded questions with the statement that withdrawal of stimulus would be determined by data but that it could begin in one of the “next few meetings.” The DJIA recovered part of the losses between 10:40AM and 2PM. The minutes of the FOMC released at 2PM on May 23, 2013, contained a phrase that troubled market participants (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm): “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.” The DJIA closed at 15,387.58 on May 21, 2013 and fell to 15,307.17 at the close on May 22, 2013, with the loss of 0.5 percent occurring after release of the minutes of the FOMC at 2PM when the DJIA stood at around 15,400. The concern about exist of the Fed from stimulus affected markets worldwide as shown in declines of equity indexes in Table III-1 with delays because of differences in trading hours. This behavior shows the trap of unconventional monetary policy with no exit from zero interest rates without risking financial crash and likely adverse repercussions on economic activity.
Financial markets worldwide were affected by the reduction of policy rates of the European Central Bank (ECB) on May 2, 2013. (http://www.ecb.int/press/pr/date/2013/html/pr130502.en.html):
“2 May 2013 - Monetary policy decisions
At today’s meeting, which was held in Bratislava, the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.50%, starting from the operation to be settled on 8 May 2013.
- The interest rate on the marginal lending facility will be decreased by 50 basis points to 1.00%, with effect from 8 May 2013.
- The interest rate on the deposit facility will remain unchanged at 0.00%.”
Financial markets in Japan and worldwide were shocked by new bold measures of “quantitative and qualitative monetary easing” by the Bank of Japan (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The objective of policy is to “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The main elements of the new policy are as follows:
- Monetary Base Control. Most central banks in the world pursue interest rates instead of monetary aggregates, injecting bank reserves to lower interest rates to desired levels. The Bank of Japan (BOJ) has shifted back to monetary aggregates, conducting money market operations with the objective of increasing base money, or monetary liabilities of the government, at the annual rate of 60 to 70 trillion yen. The BOJ estimates base money outstanding at “138 trillion yen at end-2012) and plans to increase it to “200 trillion yen at end-2012 and 270 trillion yen at end 2014” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Maturity Extension of Purchases of Japanese Government Bonds. Purchases of bonds will be extended even up to bonds with maturity of 40 years with the guideline of extending the average maturity of BOJ bond purchases from three to seven years. The BOJ estimates the current average maturity of Japanese government bonds (JGB) at around seven years. The BOJ plans to purchase about 7.5 trillion yen per month (http://www.boj.or.jp/en/announcements/release_2013/rel130404d.pdf). Takashi Nakamichi, Tatsuo Ito and Phred Dvorak, wiring on “Bank of Japan mounts bid for revival,” on Apr 4, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323646604578401633067110420.html ), find that the limit of maturities of three years on purchases of JGBs was designed to avoid views that the BOJ would finance uncontrolled government deficits.
- Seigniorage. The BOJ is pursuing coordination with the government that will take measures to establish “sustainable fiscal structure with a view to ensuring the credibility of fiscal management” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Diversification of Asset Purchases. The BOJ will engage in transactions of exchange traded funds (ETF) and real estate investment trusts (REITS) and not solely on purchases of JGBs. Purchases of ETFs will be at an annual rate of increase of one trillion yen and purchases of REITS at 30 billion yen.
The European sovereign debt crisis continues to shake financial markets and the world economy. Debt resolution within the international financial architecture requires that a country be capable of borrowing on its own from the private sector. Mechanisms of debt resolution have included participation of the private sector (PSI), or “bail in,” that has been voluntary, almost coercive, agreed and outright coercive (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Creditors and Debtors (2005), Chapter 4, 187-202). Private sector involvement requires losses by the private sector in bailouts of highly indebted countries. The essence of successful private sector involvement is to recover private-sector credit of the highly indebted country. Mary Watkins, writing on “Bank bailouts reshuffle risk hierarchy,” published on Mar 19, 2013, in the Financial Times (http://www.ft.com/intl/cms/s/0/7666546a-9095-11e2-a456-00144feabdc0.html#axzz2OSpbvCn8) analyzes the impact of the bailout or resolution of Cyprus banks on the hierarchy of risks of bank liabilities. Cyprus banks depend mostly on deposits with less reliance on debt, raising concerns in creditors of fixed-income debt and equity holders in banks in the euro area. Uncertainty remains as to the dimensions and structure of losses in private sector involvement or “bail in” in other rescue programs in the euro area. Alkman Granitsas, writing on “Central bank details losses at Bank of Cyprus,” on Mar 30, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324000704578392502889560768.html), analyzes the impact of the agreement with the €10 billion agreement with IMF and the European Union on the banks of Cyprus. The recapitalization plan provides for immediate conversion of 37.5 percent of all deposits in excess of €100,000 to shares of special class of the bank. An additional 22.5 percent will be frozen without interest until the plan is completed. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
An important risk event is the reduction of growth prospects in the euro zone discussed by European Central Bank President Mario Draghi in “Introductory statement to the press conference,” on Dec 6, 2012 (http://www.ecb.int/press/pressconf/2012/html/is121206.en.html):
“This assessment is reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.
The Governing Council continues to see downside risks to the economic outlook for the euro area. These are mainly related to uncertainties about the resolution of sovereign debt and governance issues in the euro area, geopolitical issues and fiscal policy decisions in the United States possibly dampening sentiment for longer than currently assumed and delaying further the recovery of private investment, employment and consumption.”
Reuters, writing on “Bundesbank cuts German growth forecast,” on Dec 7, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/8e845114-4045-11e2-8f90-00144feabdc0.html#axzz2EMQxzs3u), informs that the central bank of Germany, Deutsche Bundesbank reduced its forecast of growth for the economy of Germany to 0.7 percent in 2012 from an earlier forecast of 1.0 percent in Jun and to 0.4 percent in 2012 from an earlier forecast of 1.6 percent while the forecast for 2014 is at 1.9 percent.
The major risk event during earlier weeks was sharp decline of sovereign yields with the yield on the ten-year bond of Spain falling to 5.309 percent and that of the ten-year bond of Italy falling to 4.473 percent on Fri Nov 30, 2012 and 5.366 percent for the ten-year of Spain and 4.527 percent for the ten-year of Italy on Fri Nov 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Vanessa Mock and Frances Robinson, writing on “EU approves Spanish bank’s restructuring plans,” on Nov 28, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578146520774638316.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the European Union regulators approved restructuring of four Spanish banks (Bankia, NCG Banco, Catalunya Banc and Banco de Valencia), which helped to calm sovereign debt markets. Harriet Torry and James Angelo, writing on “Germany approves Greek aid,” on Nov 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578150532603095790.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the German parliament approved the plan to provide Greece a tranche of €44 billion in promised financial support, which is subject to sustainability analysis of the bond repurchase program later in Dec 2012. A hurdle for sustainability of repurchasing debt is that Greece’s sovereign bonds have appreciated significantly from around 24 percent for the bond maturing in 21 years and 20 percent for the bond maturing in 31 years in Aug 2012 to around 17 percent for the 21-year maturity and 15 percent for the 31-year maturing in Nov 2012. Declining years are equivalent to increasing prices, making the repurchase more expensive. Debt repurchase is intended to reduce bonds in circulation, turning Greek debt more manageable. Ben McLannahan, writing on “Japan unveils $11bn stimulus package,” on Nov 30, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/adc0569a-3aa5-11e2-baac-00144feabdc0.html#axzz2DibFFquN), informs that the cabinet in Japan approved another stimulus program of $11 billion, which is twice larger than another stimulus plan in late Oct and close to elections in Dec. Henry Sender, writing on “Tokyo faces weak yen and high bond yields,” published on Nov 29, 2012 in the Financial Times (http://www.ft.com/intl/cms/s/0/9a7178d0-393d-11e2-afa8-00144feabdc0.html#axzz2DibFFquN), analyzes concerns of regulators on duration of bond holdings in an environment of likelihood of increasing yields and yen depreciation.
First, Risk-Determining Events. The European Council statement on Nov 23, 2012 asked the President of the European Commission “to continue the work and pursue consultations in the coming weeks to find a consensus among the 27 over the Union’s Multiannual Financial Framework for the period 2014-2020” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf) Discussions will continue in the effort to reach agreement on a budget: “A European budget is important for the cohesion of the Union and for jobs and growth in all our countries” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf). There is disagreement between the group of countries requiring financial assistance and those providing bailout funds. Gabrielle Steinhauser and Costas Paris, writing on “Greek bond rally puts buyback in doubt,” on Nov 23, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324352004578136362599130992.html?mg=reno64-wsj) find a new hurdle in rising prices of Greek sovereign debt that may make more difficult buybacks of debt held by investors. European finance ministers continue their efforts to reach an agreement for Greece that meets with approval of the European Central Bank and the IMF. The European Council (2012Oct19 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/133004.pdf ) reached conclusions on strengthening the euro area and providing unified financial supervision:
“The European Council called for work to proceed on the proposals on the Single Supervisory Mechanism as a matter of priority with the objective of agreeing on the legislative framework by 1st January 2013 and agreed on a number of orientations to that end. It also took note of issues relating to the integrated budgetary and economic policy frameworks and democratic legitimacy and accountability which should be further explored. It agreed that the process towards deeper economic and monetary union should build on the EU's institutional and legal framework and be characterised by openness and transparency towards non-euro area Member States and respect for the integrity of the Single Market. It looked forward to a specific and time-bound roadmap to be presented at its December 2012 meeting, so that it can move ahead on all essential building blocks on which a genuine EMU should be based.”
Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. The Bank of Spain released new data on doubtful debtors in Spain’s credit institutions (http://www.bde.es/bde/en/secciones/prensa/Agenda/Datos_de_credit_a6cd708c59cf931.html). In 2006, the value of doubtful credits reached €10,859 million or 0.7 percent of total credit of €1,508,626 million. In Aug 2012, doubtful credit reached €178,579 million or 10.5 percent of total credit of €1,698,714 million.
There are three critical factors influencing world financial markets. (1) Spain could request formal bailout from the European Stability Mechanism (ESM) that may also affect Italy’s international borrowing. David Roman and Jonathan House, writing on “Spain risks backlash with budget plan,” on Sep 27, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443916104578021692765950384.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze Spain’s proposal of reducing government expenditures by €13 billion, or around $16.7 billion, increasing taxes in 2013, establishing limits on early retirement and cutting the deficit by €65 billion through 2014. Banco de España, Bank of Spain, contracted consulting company Oliver Wyman to conduct rigorous stress tests of the resilience of its banking system. (Stress tests and their use are analyzed by Pelaez and Pelaez Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005) 112-6, 123-4, 130-3).) The results are available from Banco de España (http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/ http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). The assumptions of the adverse scenario used by Oliver Wyman are quite tough for the three-year period from 2012 to 2014: “6.5 percent cumulative decline of GDP, unemployment rising to 27.2 percent and further declines of 25 percent of house prices and 60 percent of land prices (http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). Fourteen banks were stress tested with capital needs estimates of seven banks totaling €59.3 billion. The three largest banks of Spain, Banco Santander (http://www.santander.com/csgs/Satellite/CFWCSancomQP01/es_ES/Corporativo.html), BBVA (http://www.bbva.com/TLBB/tlbb/jsp/ing/home/index.jsp) and Caixabank (http://www.caixabank.com/index_en.html), with 43 percent of exposure under analysis, have excess capital of €37 billion in the adverse scenario in contradiction with theories that large, international banks are necessarily riskier. Jonathan House, writing on “Spain expects wider deficit on bank aid,” on Sep 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444138104578028484168511130.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the 2013 budget plan of Spain that will increase the deficit of 7.4 percent of GDP in 2012, which is above the target of 6.3 percent under commitment with the European Union. The ratio of debt to GDP will increase to 85.3 percent in 2012 and 90.5 percent in 2013 while the 27 members of the European Union have an average debt/GDP ratio of 83 percent at the end of IIQ2012. (2) Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even after the economy grows again at or close to potential output. Monetary easing by unconventional measures is now apparently open ended in perpetuity as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):
“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is the concern of the production and employment costs of controlling future inflation.
(2) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):
“6 September 2012 - Technical features of Outright Monetary Transactions
As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.
Securities Markets Programme
Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”
Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):
“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.
Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):
“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.
The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”
Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).
Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year, two-year and one-month Treasury constant maturity yields together with the overnight fed funds rate, and the yield of the corporate bond with Moody’s rating of Baa. The riskier yield of the Baa corporate bond exceeds the relatively riskless yields of the Treasury securities. The beginning yields in Chart III-1A for Jan 2, 1962, are 2.75 percent for the fed fund rates and 4.06 percent for the ten-year Treasury constant maturity. On July 31, 2001, the yields in Chart III-1A are 3.67 percent for one month, 3.79 percent for two years, 5.07 percent for ten years, 3.82 percent for the fed funds rate and 7.85 percent for the Baa corporate bond. On July 30, 2007, yields inverted with the one-month at 4.95 percent, the two-year at 4.59 percent and the ten-year at 5.82 percent with the yield of the Baa corporate bond at 6.70 percent. Another interesting point is for Oct 31, 2008, with the yield of the Baa jumping to 9.54 percent and the Treasury yields declining: one month 0.12 percent, two years 1.56 percent and ten years 4.01 percent during a flight to the dollar and government securities analyzed by Cochrane and Zingales (2009). Another spike in the series is for Apr 4, 2006 with the yield of the corporate Baa bond at 8.63 and the Treasury yields of 0.12 percent for one month, 0.94 for two years and 2.95 percent for ten years. During the beginning of the flight from risk financial assets to US government securities (see Cochrane and Zingales 2009), the one-month yield was 0.07 percent, the two-year yield 1.64 percent and the ten-year yield 3.41. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe. The final point of Chart III1-A is for Nov 27, 2013, with the one-month yield at 0.06 percent, the two-year at 0.28 percent, the ten-year at 2.74 percent, the fed funds rate at 0.09 percent and the corporate Baa bond at 5.34 percent (on Nov 26,2013). There is an evident increase in the yields of the 10-year Treasury constant maturity and the Moody’s Baa corporate bond with marginal reduction.
Chart III-1A, US, Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields, Overnight Fed Funds Rate and Yield of Moody’s Baa Corporate Bond, Jan 2, 1962-Nov 27, 2013
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, gross private domestic investment in the US was $951.6 billion of 2009 dollars, growing to $1,143.0 billion in IVQ1986 or 20.1 percent. Real gross private domestic investment in the US decreased 3.1 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,524.9 billion in IIQ2013. Real private fixed investment fell 4.9 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,458.4 billion in IIQ2013. Growth of real private investment in is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Corporate profits with IVA and CCA fell $26.6 billion in IQ2013 after increasing $34.9 billion in IVQ2012 and $13.9 billion in IIIQ2012. Corporate profits with IVA and CCA rebounded with $66.8 billion in IIQ2013. Profits after tax with IVA and CCA fell $1.7 billion in IQ2013 after increasing $40.8 billion in IVQ2012 and $4.5 billion in IIIQ2012. In IIQ2013, profits after tax with IVA and CCA increased $56.9 billion. Anticipation of higher taxes in the “fiscal cliff” episode caused increase of $120.9 billion in net dividends in IVQ2012 followed with adjustment in the form of decrease of net dividends by $103.8 billion in IQ2013, rebounding with $273.5 billion in IIQ2013. There is similar decrease of $80.1 billion in undistributed profits with IVA and CCA in IVQ2012 followed by increase of $102.1 billion in IQ2013 and decline of $216.6 billion in IIQ2013. Undistributed profits of US corporations swelled 263.4 percent from $107.7 billion IQ2007 to $391.4 billion in IIQ2013 and changed signs from minus $55.9 billion in billion in IVQ2007 (Section IA2). In IQ2013, corporate profits with inventory valuation and capital consumption adjustment fell $26.6 billion relative to IVQ2012, from $2047.2 billion to $2020.6 billion at the quarterly rate of minus 1.3 percent. In IIQ2013, corporate profits with IVA and CCA increased $66.8 billion from $2020.6 billion in IQ2013 to $2087.4 billion at the quarterly rate of 3.3 percent (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf). Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. The investment decision of US business is fractured. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:
Where Rτ is expected revenue in the time horizon from τ =1 to T; Cτ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or
declines.
There is mostly strong performance in equity indexes with several indexes in Table III-1 increasing in the week ending on Nov 22, 2013, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. DJIA decreased 0.1 percent on Nov 29, increasing 0.1 percent in the week. Germany’s Dax increased 0.2 percent on Fri Nov 29 and increased 2.0 percent in the week. Dow Global increased 0.4 percent on Nov 29 and increased 0.5 percent in the week. Japan’s Nikkei Average decreased 0.4 percent on Nov 29 and increased 1.8 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM increased 0.7 percent on Nov 29 and increased 0.5 percent in the week. Shanghai Composite that decreased 0.2 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 to close at 1980.13 on Fri Nov 30 but closing at 2220.50 on Nov 29 for increase of 0.1 percent and increase of 1.1 percent in the week of Nov 29. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite.
Commodities were mixed in the week of Nov 29, 2013. The DJ UBS Commodities Index increased 0.5 percent on Fri Nov 29 and increased 0.3 percent in the week, as shown in Table III-1. WTI decreased 2.2 percent in the week of Nov 29 while Brent decreased 1.2 percent in the week. Gold increased 0.5 percent on Fri Nov 29 and increased 0.5 percent in the week.
Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €717,615 million on Nov 22, 2013 with some repayment of loans already occurring. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €1,309,887 million in the statement of Nov 22, 2013, with marginal reduction. There is high credit risk in these transactions with capital of only €90,420 million as analyzed by Cochrane (2012Aug31).
Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Nov 22, 2013 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 343,920 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 244,948 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 22,805 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 19,381 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 717,615 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 81,441 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 592,272 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 28,328 |
| 9 Other Assets | 278,719 | 336,574 | 242,891 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 2,293,601 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,309,887 |
| Capital and Reserves | 78,143 | 81,481 | 90,420 |
Source: European Central Bank
http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html
http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html
http://www.ecb.europa.eu/press/pr/wfs/2013/html/fs131126.en.html
IIIE Appendix Euro Zone Survival Risk. Resolution of the European sovereign debt crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common euro currency prevents Italy from devaluing the exchange to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness.
Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would ensure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 40.6 percent of the total in Jan-Sep 2013. Exports to the non-European Union area with share of 45.7 percent in Italy’s total exports are growing at 2.1 percent in Jan-Sep 2013 relative to Jan-Sep 2012 while those to EMU are growing at minus 3.2 percent.
Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%
| Sep 2013 | Exports | ∆% Jan-Sep 2013/ Jan-Sep 2012 | Imports | ∆% Jan-Sep 2013/ Jan-Sep 2012 |
| EU | 54.3 | -2.3 | 53.3 | -2.2 |
| EMU 17 | 40.6 | -3.2 | 42.7 | -2.3 |
| France | 11.1 | -2.9 | 8.3 | -5.0 |
| Germany | 12.5 | -2.6 | 14.5 | -5.2 |
| Spain | 4.7 | -7.4 | 4.5 | -4.3 |
| UK | 4.9 | 2.3 | 2.6 | -2.4 |
| Non EU | 45.7 | 2.1 | 46.7 | -10.3 |
| Europe non EU | 13.4 | -1.5 | 10.9 | 4.8 |
| USA | 6.8 | -1.5 | 3.3 | -12.4 |
| China | 2.3 | 10.5 | 6.6 | -9.3 |
| OPEC | 5.7 | 8.2 | 10.8 | -27.3 |
| Total | 100.0 | -0.3 | 100.0 | -6.1 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/103528
Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €891 million with the 17 countries of the euro zone (EMU 17) in Sep 2013 and cumulative deficit of €2626 million in Jan-Sep 2013. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €5694 million in Jan-Sep 2013 with Europe non European Union, the trade surplus of €11,048 million with the US and trade surplus with non-European Union of €11,304 million in Jan-Sep 2013. There is significant rigidity in the trade deficits in Jan-Sep 2013 of €10,535 million with China and €5902 million with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.
Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro
| Regions and Countries | Trade Balance Sep 2013 Millions of Euro | Trade Balance Cumulative Jan-Sep 2013 Millions of Euro |
| EU | 472 | 8,300 |
| EMU 17 | -891 | -2,626 |
| France | 977 | 9,245 |
| Germany | -560 | -3,101 |
| Spain | 87 | 660 |
| UK | 914 | 7,418 |
| Non EU | 322 | 11,304 |
| Europe non EU | 639 | 5,694 |
| USA | 1,060 | 11,048 |
| China | -1,449 | -10,535 |
| OPEC | -394 | -5,902 |
| Total | 794 | 19,605 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/103528
Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Sep 2013 relative to Jan-Sep 2012. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 16.7 percent and positive with 2.0 percent for durable goods. The higher rate of growth of exports of minus 0.3 percent in Jan-Sep 2013/Jan-Sep 2012 relative to imports of minus 6.1 percent may reflect weak demand in Italy with GDP declining during nine consecutive quarters from IIIQ2011 through IIIQ2013 together with softening commodity prices.
Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%
| Exports | Exports | Imports | Imports | |
| Consumer | 29.3 | 5.8 | 25.6 | 0.6 |
| Durable | 5.8 | 1.7 | 2.9 | -10.2 |
| Non-Durable | 23.5 | 6.8 | 22.6 | 2.0 |
| Capital Goods | 31.6 | 1.5 | 19.8 | -3.4 |
| Inter- | 33.6 | -4.1 | 32.4 | -5.5 |
| Energy | 5.5 | -20.5 | 22.2 | -16.7 |
| Total ex Energy | 94.5 | 0.8 | 77.8 | -3.0 |
| Total | 100.0 | -0.3 | 100.0 | -6.1 |
Note: % Share for 2012 total trade.
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/103528
Table III-6 provides Italy’s trade balance by product categories in Sep 2013 and cumulative Jan-Sep 2013. Italy’s trade balance excluding energy generated surplus of €4946 million in Sep 2013 and €60,753 million cumulative in Jan-Sep 2013 but the energy trade balance created deficit of €4152 million in Sep 2013 and cumulative €41,148 million in Jan-Sep 2013. The overall surplus in Sep 2013 was €794 million with cumulative surplus of €19,605 million in Jan-Sep 2013. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.
Table III-6, Italy, Trade Balance by Product Categories, € Millions
| Sep 2013 | Cumulative Jan-Sep 2013 | |
| Consumer Goods | 1,526 | 15,930 |
| Durable | 922 | 9,373 |
| Nondurable | 604 | 6,556 |
| Capital Goods | 3,657 | 38,700 |
| Intermediate Goods | -238 | 6,123 |
| Energy | -4,152 | -41,148 |
| Total ex Energy | 4,946 | 60,753 |
| Total | 794 | 19,605 |
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/103528
Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.
The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).
Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.
Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:
“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”
If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.
The prospects of survival of the euro zone are dire. Table III-7 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2013.
Table III-7, World and Selected Regional and Country GDP and Fiscal Situation
| GDP 2013 | Primary Net Lending Borrowing | General Government Net Debt | |
| World | 73,454 | ||
| Euro Zone | 12,685 | -0.4 | 74.9 |
| Portugal | 219 | 0.1 | 119.3 |
| Ireland | 221 | -3.3 | 105.5 |
| Greece | 243 | -- | 172.6 |
| Spain | 1,356 | -3.7 | 80.7 |
| Major Advanced Economies G7 | 34,068 | -3.8 | 91.5 |
| United States | 16,724 | -3.6 | 87.4 |
| UK | 2,490 | -4.7 | 84.8 |
| Germany | 3,593 | 1.7 | 56.3 |
| France | 2,739 | -2.0 | 87.2 |
| Japan | 5,007 | -8.8 | 139.9 |
| Canada | 1,825 | -2.8 | 36.5 |
| Italy | 2,068 | 2.0 | 110.5 |
| China | 8,939 | -2.5* | 22.9** |
*Net Lending/borrowing**Gross Debt
Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx
The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2013” to the column “GDP USD Billions.” The total debt of France and Germany in 2013 is $4411.3 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4293.3 billion, adding rows D+E+F+G+H in column “Net Debt USD billions.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-8. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8704.6 billion, which would be equivalent to 137.5 percent of their combined GDP in 2013. Under this arrangement, the entire debt of selected members of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 242.3 percent if including debt of France and 175.8 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing
Table III-8, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %
| Net Debt USD Billions | Debt as % of Germany Plus France GDP | Debt as % of Germany GDP | |
| A Euro Area | 9,501.1 | ||
| B Germany | 2,022.9 | $8704.6 as % of $3593 =242.3% $6316.2 as % of $3593 =175.8% | |
| C France | 2,388.4 | ||
| B+C | 4,411.3 | GDP $6,332.0 Total Debt $8704.6 Debt/GDP: 137.5% | |
| D Italy | 2,285.1 | ||
| E Spain | 1,094.3 | ||
| F Portugal | 261.3 | ||
| G Greece | 419.4 | ||
| H Ireland | 233.2 | ||
| Subtotal D+E+F+G+H | 4,293.3 |
Source: calculation with IMF data IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx
There is extremely important information in Table III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Sep 2013. German exports to other European Union (EU) members are 57.9 percent of total exports in Sep 2013 and 57.0 percent in cumulative Jan-Sep 2013. Exports to the euro area are 37.3 percent of the total in Sep and 36.8 percent cumulative in Jan-Sep. Exports to third countries are 42.0 percent of the total in Sep and 43.0 percent cumulative in Jan-Sep. There is similar distribution for imports. Exports to non-euro countries are increasing 7.2 percent in the 12 months ending in Sep 2013, increasing 1.1 percent cumulative in Jan-Sep 2013 while exports to the euro area are increasing 4.4 percent in the 12 months ending in Sep 2013 and decreasing 2.0 percent cumulative in Jan-Sep 2013. Exports to third countries, accounting for 42.0 percent of the total in Sep 2013, are increasing 1.2 percent in the 12 months ending in Sep 2013 and decreasing 0.8 percent cumulative in Jan-Sep 2013, accounting for 43.0 percent of the cumulative total in Jan-Sep 2013. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to Germany’s high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of high share in its exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.
Table III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%
| Sep 2013 | Sep 12-Month | Cumulative Jan-Sep 2012 € Billions | Cumulative Jan-Sep 2013/ | |
| Total | 94.7 | 3.6 | 818.0 | -0.9 |
| A. EU | 54.8 % 57.9 | 5.4 | 466.2 % 57.0 | -0.9 |
| Euro Area | 35.3 % 37.3 | 4.4 | 301.0 % 36.8 | -2.0 |
| Non-euro Area | 19.5 % 20.6 | 7.2 | 165.2 % 20.2 | 1.1 |
| B. Third Countries | 39.8 % 42.0 | 1.2 | 351.8 % 43.0 | -0.8 |
| Total Imports | 74.3 | -0.3 | 670.2 | -1.4 |
| C. EU Members | 48.2 % 64.9 | 2.6 | 430.6 % 64.2 | 0.2 |
| Euro Area | 33.0 % 44.4 | 1.8 | 300.1 % 44.8 | -0.8 |
| Non-euro Area | 15.2 % 20.5 | 4.4 | 130.5 % 19.5 | 2.6 |
| D. Third Countries | 26.1 % 35.1 | -5.2 | 239.6 % 35.8 | -4.3 |
Notes: Total Exports = A+B; Total Imports = C+D
Source: Statistisches Bundesamt Deutschland
https://www.destatis.de/EN/PressServices/Press/pr/2013/11/PE13_372_51.html
IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.
First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:
D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)
Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,
{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:
N(t+1) = (1+n)N(t), n>-1 (2)
The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:
B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)
On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.
Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1, updated with every blog comment, provides the latest annual data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of sovereign risk issues (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.
Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 1.6 | 1.0 | 0.3 | 7.3 |
| Japan | 2.7 | 1.1 | 2.3 | 4.0 |
| China | 7.8 | 3.2 | -1.5 | |
| UK | 1.5 | 2.2* CPIH 2.0 | 0.8 output | 7.6 |
| Euro Zone | -0.4 | 0.7 | -0.9 | 12.1 |
| Germany | 0.6 | 1.2 | -0.4 | 5.2 |
| France | 0.2 | 0.7 | -0.4 | 10.9 |
| Nether-lands | -0.8 | 1.3 | -2.7 | 7.0 |
| Finland | -0.2 | 1.7 | 0.3 | 8.1 |
| Belgium | 0.4 | 0.7 | -0.9 | 9.0 |
| Portugal | -1.0 | 0.0 | -1.5 | 15.7 |
| Ireland | NA | -0.1 | 2.1 | 12.6 |
| Italy | -1.9 | 0.8 | -2.2 | 12.5 |
| Greece | NA | -1.9 | -1.4 | NA |
| Spain | -1.2 | 0.0 | 0.1 | 26.7 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Office for National Statistics http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/october-2013/index.html **Core
PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/october-2013/index.html
Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/; country statistical sources http://www.census.gov/aboutus/stat_int.html
Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 1.6 percent in IIIQ2013 relative to IIIQ2012 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html, Table 8 in http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). Japan’s GDP grew 0.5 percent in IIIQ2013 relative to IIQ2013 and 2.7 percent relative to a year earlier. Japan’s grew at the seasonally adjusted annual rate (SAAR) of 1.9 percent in IIIQQ2013 (Section VB http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-unwinding-monetary-policy.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html). The UK grew at 0.8 percent in IIIQ2013 relative to IIQ2013 and GDP increased 1.5 percent in IIIQ2013 relative to IIIQ2012 (Section VH and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html). The Euro Zone grew at 0.1 percent in IIIQ2013 and minus 0.4 percent in IIIQ2013 relative to IIIQ2012 (Section VD http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-unwinding-monetary-policy.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/imf-view-collapse-of-united-states.html ). These are stagnating or “growth recession” rates, which are positive or about nil growth rates with some contractions that are insufficient to recover employment. The rates of unemployment are quite high: 7.3 percent in the US but 17.7 percent for unemployment/underemployment or job stress of 28.9 million (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html), 4.0 percent for Japan (Section VB and earlier http://cmpassocregulationblog.blogspot.com/2013/10/collapse-of-united-states-dynamism-of.html), 7.6 percent for the UK with high rates of unemployment for young people (Section VH http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-unwinding-monetary-policy.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 1.0 percent in the US, 1.1 percent for Japan, 3.2 percent for China, 0.7 percent for the Euro Zone and 2.2 percent for the UK. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. Six key interrelated vulnerabilities in the world economy have been causing global financial turbulence. (1) Sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III and earlier http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html). (2) The tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment and political developments in a decennial transition. (3) Slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html), weak hiring with the loss of 10 million full-time jobs (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html). (4) The timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies. (5) The Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 had repercussions throughout the world economy. Japan has share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) geopolitical events in the Middle East.
In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These policies and views are discussed initially followed with appropriate analysis.
Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):
“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.
Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.
The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”
Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:
“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”
The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):
“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.”
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans. Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 1.8 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that US economic growth has been at only 2.3 percent on average in the cyclical expansion in the 17 quarters from IIIQ2009 to IIIQ2013. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf
http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) and the first estimate of GDP for IIIQ2013 (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). As a result, there are 28.9 million unemployed or underemployed in the United States for an effective unemployment rate of 17.7 percent (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html). The US missed the opportunity of fast growth in the first four quarters of cyclical expansion when unemployment and underemployment are reduced. Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.
First, total nonfarm payroll employment seasonally adjusted (SA) increased 204,000 in Oct 2013 and private payroll employment rose 212,000. The average number of nonfarm jobs created in Jan-Oct 2012 was 172,700 while the average number of nonfarm jobs created in Jan-Sep 2013 was 186,300, or increase by 7.9 percent. The average number of private jobs created in the US in Jan-Oct 2012 was 178,900 while the average in Jan-Sep 2013 was 187,500, or increase by 4.8 percent. The US labor force increased from 153.617 million in 2011 to 154.975 million in 2012 by 1.358 million or 113,167 per month. The average increase of nonfarm jobs in the ten months from Jan to Oct 2013 was 186,300, which is a rate of job creation inadequate to reduce significantly unemployment and underemployment in the United States because of 113,167 new entrants in the labor force per month with 28.9 million unemployed or underemployed. The difference between the average increase of 186,300 new private nonfarm jobs per month in the US from Jan to Oct 2013 and the 113,167 average monthly increase in the labor force from 2011 to 2012 is 73,133 monthly new jobs net of absorption of new entrants in the labor force. There are 28.9 million in job stress in the US currently. Creation of 73,133 new jobs per month net of absorption of new entrants in the labor force would require 396 months to provide jobs for the unemployed and underemployed (28.942 million divided by 73,133) or 33 years (396 divided by 12). The civilian labor force of the US in Oct 2013 not seasonally adjusted stood at 155.918 million with 10.773 million unemployed or effectively 18.959 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 163.104 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 73.133 by 12, which is 877,596). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.746 million (0.05 times labor force of 154.918 million) for new net job creation of 3.027 million (10.773 million unemployed minus 7.746 million unemployed at rate of 5 percent) that at the current rate would take 3.4 years (3.027 million divided by 0.877596). Under the calculation in this blog, there are 18.959 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 163.104 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 10.164 million jobs net of labor force growth that at the current rate would take 12.3 years (18.959 million minus 0.05(163.104 million) = 10.804 million divided by 0.877596, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in Oct 2013 was 144.144 million (NSA) or 3.171 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population increased from 231.958 million in Jul 2007 to 246.381 million in Oct 2013 or by 14.423 million. The number employed fell 2.2 percent from Jul 2007 to Oct 2013 while population increased 6.2 percent. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions. Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design.
Second, there are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf
http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) and the first estimate of GDP for IIIQ2013 (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). As a result, there are 28.9 million unemployed or underemployed in the United States for an effective unemployment rate of 17.7 percent (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.htmland earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html).
The economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.8 percent in 2011 to 2.8 percent in 2012. The following calculations show that actual growth is around 2.0 to 2.2 percent per year. This rate is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May).
Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.
- Long-term. US GDP grew at the average yearly rate of 3.3 percent from 1929 to 2012 and at 3.2 percent from 1947 to 2012. There were periodic contractions or recessions in this period but the economy grew at faster rates in the subsequent expansions, maintaining long-term economic growth at trend.
- Cycles. The combined contraction of GDP in the two almost consecutive recessions in the early 1980s is 4.7 percent. The contraction of US GDP from IVQ2007 to IIQ2009 during the global recession was 4.3 percent. The critical difference in the expansion is growth at average 7.8 percent in annual equivalent in the first four quarters of recovery from IQ1983 to IVQ1983. The average rate of growth of GDP in four cyclical expansions in the postwar period is 7.7 percent. In contrast, the rate of growth in the first four quarters from IIIQ2009 to IIQ2010 was only 2.7 percent. Average annual equivalent growth in the expansion from IQ1983 to IQ1986 was 5.7 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIIQ2013 was only 2.3 percent. The US appears to have lost its dynamism of income growth and employment creation.
Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita
| GDP | ||
| Long-Term | ||
| 1929-2012 | 3.3 | |
| 1947-2012 | 3.2 | |
| Cyclical Contractions ∆% | ||
| IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982 | -4.7 | |
| IVQ2007 to IIQ2009 | -4.3 | |
| Cyclical Expansions Average Annual Equivalent ∆% | ||
| IQ1983 to IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 | 5.7 5.4 5.2 5.0 | |
| First Four Quarters IQ1983 to IVQ1983 | 7.8 | |
| IIIQ2009 to IIIQ2013 | 2.3 | |
| First Four Quarters IIIQ2009 to IIQ2010 | 2.7 | |
| Real Disposable Income | Real Disposable Income per Capita | |
| Long-Term | ||
| 1929-2012 | 3.2 | 2.0 |
| 1947-1999 | 3.7 | 2.3 |
| Whole Cycles | ||
| 1980-1989 | 3.5 | 2.6 |
| 2006-2012 | 1.4 | 0.6 |
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.pdf
http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf
The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 2.0 to 2.2 percent per year. Table Summary GDP provides the data.
1. Average Annual Growth in the Past Six Quarters. GDP growth in the four quarters of 2012 and the first three quarters of 2013 accumulated to 3.6 percent. This growth is equivalent to 2.0 percent per year, obtained by dividing GDP in IIIQ2013 of $15,790.1 by GDP in IVQ2011 of $15,242.1 and compounding by 4/7: {[($15,790.1/$15,242.1)4/6 -1]100 = 2.0.
2. Average Annual Growth in the First Three Quarters of 2013. GDP growth in the first three quarters of 2013 accumulated to 1.6 percent that is equivalent to 2.2 percent in a year. This is obtained by dividing GDP in IIIQ2013 of $15,790.1 by GDP in IVQ2012 of $15,539.6 and compounding by 4/3: {[($15,790.1/$15,539.6)4/3 -1]100 = 2.2%}. The US economy grew 1.6 percent in IIIQ2013 relative to the same quarter a year earlier in IIIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is just at the borderline of contraction.
Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2009 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 14,996.1 | NA | NA | 1.9 |
| IVQ2011 | 15,242.1 | 1.6 | 1.2 | 2.0 |
| IQ2012 | 15,381.6 | 2.6 | 0.9 | 3.3 |
| IIQ2012 | 15,427.7 | 2.9 | 0.3 | 2.8 |
| IIIQ2012 | 15,534.0 | 3.6 | 0.7 | 3.1 |
| IVQ2012 | 15,539.6 | 3.6 | 0.0 | 2.0 |
| IQ2013 | 15,583.9 | 3.9 | 0.3 | 1.3 |
| IIQ2013 | 15,679.7 | 4.6 | 0.6 | 1.6 |
| IIIQ2013 | 15,790.1 | 5.3 | 0.7 | 1.6 |
| Cumulative ∆% IQ2012 to IIIQ2013 | 2.9 | 3.6 | ||
| Annual Equivalent ∆% | 1.9 | 2.0 |
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation, QE→∞ cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.
The statement of the FOMC at the conclusion of its meeting on Dec 12, 2012, revealed policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm) practically unchanged in the statement at the conclusion of its meeting on Jan 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130130a.htm) and at its meeting on Oct 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20131030a.htm):
“Press Release
Release Date: October 30, 2013
For immediate release
Information received since the Federal Open Market Committee met in September generally suggests that economic activity has continued to expand at a moderate pace. Indicators of labor market conditions have shown some further improvement, but the unemployment rate remains elevated. Available data suggest that household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months. Fiscal policy is restraining economic growth. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.
Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.”
There are several important issues in this statement.
- Mandate. The FOMC pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
- Open-ended Quantitative Easing or QE∞. Earlier programs are continued with an additional open-ended $85 billion of bond purchases per month: “However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.”
- Advance Guidance on “6 ¼ 2 ½ “Rule. Policy will be accommodative even after the economy recovers satisfactorily: “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
- Monitoring and Policy Focus on Jobs. The FOMC reconsiders its policy continuously in accordance with available information: “In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”
- No Present Course of Asset Purchases. Market participants focused on slightly different wording about asset purchases: “In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”
- Growth. “The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.”
Current focus is on tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “paring” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Oct 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20131030a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent.” (emphasis added).
There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful?
At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:
“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.
For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differfrom each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (10
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:
“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. Indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness.
In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.
Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exist from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.
Table IV-2 provides economic projections of governors of the Board of Governors of the Federal Reserve and regional presidents of Federal Reserve Banks released at the meeting of Sep 18, 2013. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for IIIQ2013 is analyzed in Section I (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html) and the PCE inflation data from the report on personal income and outlays in Section IV (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The Bureau of Economic Analysis (BEA) provides the estimate of IIQ2013 GDP released on Sep 26 with revisions since 1929 (http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The BEA provides the first estimate of IIIQ2013 GDP released on Nov 8, 2013 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html). PCE inflation is the index of personal consumption expenditures (PCE) of the report of the Bureau of Economic Analysis (BEA) on “Personal Income and Outlays” (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm), which is analyzed in Section IV (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The report on “Personal Income and Outlays” for Sep 2013 was released on Nov 8, 2013 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). PCE core inflation consists of PCE inflation excluding food and energy. Column “UNEMP %” is the rate of unemployment measured as the average civilian unemployment rate in the fourth quarter of the year. The Bureau of Labor Statistics (BLS) provides the Employment Situation Report with the civilian unemployment rate in the first Friday of every month, which is analyzed in this blog. The report for Jul 2013 was released on Aug 2 and analyzed in this blog and the report for Aug 2013 was released on Sep 6, 2013 (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html
and earlier http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). The report for Sep 2013 was released on Oct 22, 2013 (http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html
and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html). The report for Oct 2013 was released on Nov 8, 2013 (http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html). “Longer term projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20121212.pdf).
It is instructive to focus on 2013 and 2014 because 2015, 2016 and longer term are too far away, and there is not much information even on what will happen in 2013-2014 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC but the second block of numbers provides the range of projections by FOMC participants. The first row for each year shows the projection introduced after the meeting of Sep 18, 2013 and the second row “PR” the projection of the Jun 19, 2013 meeting. There are three major changes in the view.
1. Growth “∆% GDP.” The FOMC has reduced the forecast of GDP growth in 2013 from 2.3 to 2.6 percent at the meeting in Jun 2013 to 2.0 to 2.3 percent at the meeting on Sep 18, 2013. The FOMC decreased GDP growth in 2014 from 3.0 to 3.5 percent at the meeting in Jun 2013 to 2.9 to 3.1 percent at the meeting in Sep 2013.
2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment from 7.2 to 7.3 percent at the meeting on Jun 19, 2013 to 7.1 to 7.3 percent at the meeting on Sep 18, 2013. The projection for 2014 decreased to the range of 6.4 to 6.8 in Sep 2013 from 6.5 to 6.8 in Jun 2013. Projections of the rate of unemployment are moving closer to the desire 6.5 percent or lower with 5.9 to 6.2 percent in 2015 after the meeting on Sep 18, 2013.
3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 0.8 to 1.2 percent at the meeting on Jun 19, 2012 to 1.1 to 1.2 percent at the meeting on Sep 18, 2013. There are no projections exceeding 2.0 percent in the central tendency but some in the range reach 2.3 percent in 2015 and 2015. The longer run projection is at 2.0 percent.
4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection, changing from 1.2 to 1.3 percent at the meeting on Jun 19, 2013 to 1.2 to 1.3 percent at the meeting Sep 13, 2013. In 2014, there is minor change in the projection from 1.5 to 1.8 percent in Jun 19, 2013 to 1.5 to 1.7 percent in Sep 18, 2013. The rate of change of the core PCE is below 2.0 percent in the central tendency with 2.3 percent at the top of the range in 2015 and 2016.
Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, Mar 2013 and Jun 19, 2013
| ∆% GDP | UNEM % | ∆% PCE Inflation | ∆% Core PCE Inflation | |
| Central | ||||
| 2013 | 2.0 to 2.3 | 7.1 to 7.3 | 1.1 to 1.2 | 1.2 to 1.3 1.2 to 1.3 |
| 2014 | 2.9 to 3.1 | 6.4 to 6.8 | 1.3 to 1.8 | 1.5 to 1.7 |
| 2015 Jun PR | 3.0 to 3.5 2.9 to 3.6 | 5.9 to 6.2 5.8 to 6.2 | 1.6 to 2.0 1.7 to 2.0 | 1.7 to 2.0 1.7 to 2.0 |
| 2016 Jun PR | 2.5 to 3.3 NA | 5.4 to 5.9 NA | 1.7 to 2.0 NA | 1.9 to 2.0 NA |
| Longer Run Jun PR | 2.2 to 2.5 2.3 to 2.5 | 5.2 to 5.8 5.2 to 6.0 | 2.0 2.0 | |
| Range | ||||
| 2013 | 1.8 to 2.4 | 6.9 to 7.3 | 1.0 to 1.3 | 1.2 to 1.4 |
| 2014 | 2.2 to 3.3 | 6.2 to 6.9 | 1.2 to 2.0 | 1.4 to 2.0 |
| 2015 Jun PR | 2.2 to 3.7 2.3 to 3.8 | 5.3 to 6.3 5.7 to 6.4 | 1.4 to 2.3 1.6 to 2.3 | 1.6 to 2.3 1.7 to 2.3 |
| 2016 Jun PR | 2.2 to 3.5 NA | 5.2 to 6.0 NA | 1.5 to 2.3 NA | 1.7 to 2.3 NA |
| Longer Run Jun PR | 2.1 to 2.5 2.0 to 3.0 | 5.2 to 6.0 5.0 to 6.0 | 2.0 2.0 |
Notes: UEM: unemployment; PR: Projection
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf
Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):
“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.
The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.
Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.
The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.
In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”
The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html See Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-116). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.
The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2013, 2014, 2015, 2016 and the in the longer term. Table IV-3 is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). There are 17 participants expecting the rate to remain at 0 to ¼ percent in 2013. The rate would still remain at 0 to ¼ percent in 2014 for 13 participants with three expecting the rate to be in the range of 0.5 to 1.0 percent and one participant expecting rates at 1.0 to 1.5 percent. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels. For 2015, eight participants expect rates to be below or at 1.0 percent while six expect rates from 1.0 to 1.5 percent and three expecting rates in excess of 2.0 percent. For 2016, nine participants expect rates between 1.0 and 2.0 percent, four between 2.0 and 3.0 percent and three between 3.0 and 4.4 percent. In the long term, all 17 participants expect the fed funds rate in the range of 3.0 to 4.5 percent.
Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board
Members and Federal Reserve Bank Presidents Participating in FOMC, Jun 19, 2013
| 0 to 0.25 | 0.5 to 1.0 | 1.0 to 1.5 | 1.0 to 2.0 | 2.0 to 3.0 | 3.0 to 4.5 | |
| 2013 | 17 | |||||
| 2014 | 13 | 3 | 1 | |||
| 2015 | 8 | 6 | 3 | |||
| 2016 | 1 | 9 | 4 | 3 | ||
| Longer Run | 17 |
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf
Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2013 to 2016. It is evident from Table IV-4 that the prevailing view of the FOMC is for interest rates to continue at low levels in future years. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2. The FOMC states that rates will continue to be low even after return of the economy to potential growth.
Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal
Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, June 19, 2013
| Appropriate Year of Increasing Target Fed Funds Rate | Number of Participants |
| 2014 | 3 |
| 2015 | 12 |
| 2016 | 2 |
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf
Unconventional monetary policy of zero interest rates and quantitative easing has been used in Japan and now also in the US. Table IV-5 provides the consumer price index of Japan, with inflation of 1.1 percent in 12 months ending in Oct 2013 and increase of 0.1 percent NSA (not-seasonally-adjusted) in Oct 2013. Inflation of consumer prices in the first three months of 2012 annualizes at 0.0 percent NSA. Inflation in Mar-Oct 2013 not seasonally adjusted annualizes at 2.3 percent. There are negative percentage changes in most of the 12-month rates in 2011 with the exception of Jul and Aug both with 0.2 percent and stability in Sep. All 12-month rates of inflation in the first five months of 2013 are negative. Inflation in the 12 months ending in Jun 2013 was 0.2 percent and 0.7 percent in the 12 months ending in Jul 2013. Inflation increased to 0.9 percent in the 12 months ending in Aug 2013 and 1.1 percent in the 12 months ending in Sep 2013. Inflation was 1.1 percent in the 12 months ending in Oct 2013. There are ten years of deflation, three of zero inflation and only five of inflation in the annual rate of inflation from 1995 to 2012. This experience is entirely different from that of the US that shows long-term inflation. There is only one annual negative change of the CPI all items of the US in Table IV-5, minus 0.4 percent in 2009 but following 3.8 percent in 2008 because of carry trades from policy rates moving to zero in 2008 during a global contraction that were reversed because of risk aversion in late 2008 and early 2009, causing decreasing commodity prices. Both the US and Japan experienced high rates of inflation during the US Great Inflation of the 1970s (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). It is difficult to justify unconventional monetary policy because of risks of deflation similar to that experienced in Japan. Fear of deflation as had occurred during the Great Depression and in Japan was used as an argument for the first round of unconventional monetary policy with 1 percent interest rates from Jun 2003 to Jun 2004. The 1 percent interest rate combined with quantitative easing in the form of withdrawal of supply of 30-year securities by suspension of the auction of 30-year Treasury bonds with the intention of reducing mortgage rates. For fear of deflation, see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html
Table IV-5, Japan, Consumer Price Index, All Items ∆%
| ∆% Month NSA | ∆% 12-Month NSA | |
| Oct 2013 | 0.1 | 1.1 |
| Sep | 0.3 | 1.1 |
| Aug | 0.3 | 0.9 |
| Jul | 0.2 | 0.7 |
| Jun | 0.0 | 0.2 |
| May | 0.1 | -0.3 |
| Apr | 0.3 | -0.7 |
| Mar | 0.2 | -0.9 |
| Feb | -0.2 | -0.7 |
| Jan | 0.0 | -0.3 |
| Dec 2012 | 0.0 | -0.1 |
| Nov | -0.4 | -0.2 |
| Oct | 0.0 | -0.4 |
| Sep | 0.1 | -0.3 |
| Aug | 0.1 | -0.4 |
| Jul | -0.3 | -0.4 |
| Jun | -0.5 | -0.2 |
| May | -0.3 | 0.2 |
| Apr | 0.1 | 0.4 |
| Mar | 0.5 | 0.5 |
| Feb | 0.2 | 0.3 |
| Jan | 0.2 | 0.1 |
| Dec 2011 | 0.0 | -0.2 |
| Nov | -0.6 | -0.5 |
| Oct | 0.1 | -0.2 |
| Sep | 0.0 | 0.0 |
| Aug | 0.1 | 0.2 |
| Jul | 0.0 | 0.2 |
| Jun | -0.2 | -0.4 |
| May | 0.0 | -0.4 |
| Apr | 0.1 | -0.5 |
| Mar | 0.3 | -0.5 |
| Feb | 0.0 | -0.5 |
| Jan | -0.1 | -0.6 |
| Dec 2010 | –0.3 | 0.0 |
| CPI All Items USA | CPI All Items Japan | |
| Annual | ||
| 2012 | 2.1 | 0.0 |
| 2011 | 3.2 | -0.3 |
| 2010 | 1.6 | -0.7 |
| 2009 | -0.4 | -1.4 |
| 2008 | 3.8 | 1.4 |
| 2007 | 2.8 | 0.0 |
| 2006 | 3.2 | 0.3 |
| 2005 | 3.4 | -0.3 |
| 2004 | 2.7 | 0.0 |
| 2003 | 2.3 | -0.3 |
| 2002 | 1.6 | -0.9 |
| 2001 | 2.8 | -0.7 |
| 2000 | 3.4 | -0.7 |
| 1999 | 2.2 | -0.3 |
| 1998 | 1.6 | 0.6 |
| 1997 | 2.3 | 1.8 |
| 1996 | 3.0 | 0.1 |
| 1995 | 2.8 | -0.1 |
| 1994 | 2.6 | 0.7 |
| 1993 | 3.0 | 1.3 |
| 1992 | 3.0 | 1.6 |
| 1991 | 4.2 | 3.3 |
| 1990 | 5.4 | 3.1 |
| 1989 | 4.8 | 2.3 |
| 1988 | 4.1 | 0.7 |
| 1987 | 3.6 | 0.1 |
| 1986 | 1.9 | 0.6 |
| 1985 | 3.6 | 2.0 |
| 1984 | 4.3 | 2.3 |
| 1983 | 3.2 | 1.9 |
| 1982 | 6.2 | 2.8 |
| 1981 | 10.3 | 4.9 |
| 1980 | 13.5 | 7.7 |
| 1979 | 11.3 | 3.7 |
| 1978 | 7.6 | 4.2 |
| 1977 | 6.5 | 8.1 |
| 1976 | 5.8 | 9.4 |
| 1975 | 9.1 | 11.7 |
| 1974 | 11.0 | 23.2 |
| 1973 | 6.2 | 11.7 |
| 1972 | 3.2 | 4.9 |
| 1971 | 4.4 | 6.3 |
Source: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications
http://www.stat.go.jp/english/data/cpi/index.htm
Japan’s Statistics Bureau at the Ministry of Internal Affairs and Communications provides the consumer price index for all items and regions of Japan monthly from 1971 to 2013 with 2010=100, shown in Chart IV-1. There was inflation in Japan during the 1970s and 1980s similar to other countries and regions. The index shows stability after the 1990s with sporadic cases of deflation. Slower growth with sporadic inflation has been characterized as a “lost decade” in Japan (see Pelaez and Pelaez, The Global Recession Risk (2007), 82-115).
Chart IV-1, Japan, Consumer Price Index All Items, All Japan, Index 2010=100, Monthly, 1970-2013
Source: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications
http://www.stat.go.jp/english/data/cpi/index.htm
Chart IV-2 provides the US consumer price index NSA from 1914 to 2013. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.
Chart IV-2, US, Consumer Price Index, All Items, NSA, 1914-2013
Source: US Bureau of Labor Statistics
Chart IV-3 of the Statistics Bureau of the Ministry of Internal Affairs and Communications of Japan provides 12-month percentage changes of the consumer price index for all items and regions of Japan monthly from 1971 to 2013. Japan experienced the same inflation waves of the United States during the Great Inflation of the 1970s followed by similar low inflation after the inflation-control increase of interest rates in the early 1980s. Numerous cases of negative inflation or deflation are observed after the 1990s.
Chart IV-3, Japan, CPI All Items, All Japan, 12-Month ∆%, 1971-2013
Sources: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications
http://www.stat.go.jp/english/data/cpi/index.htm
Chart IV-4 provides 12-month percentage changes of the US consumer price index from 1914 to 2013. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Table IV-5 provides similar inflation waves in the economy of Japan with 11.7 percent in 1973, 23.1 percent in 1974 and 11.7 percent in 1975. The Great Inflation of the 1970s is analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and in Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). Inflation rates then stabilized in the US in a range with only two episodes above 5 percent. There are isolated cases of deflation concentrated over extended periods only during the 1930s. There is no case in United States economic history for unconventional monetary policy because of fear of deflation. There are cases of long-term deflation without lost decades or depressions.
Delfim Netto (1958) partly reprinted in Pelaez (1973) conducted two classical nonparametric tests (Mann 1945, Wallis and Moore 1941; see Kendall and Stuart 1968) with coffee-price data in the period of free markets from 1857 to 1906 with the following conclusions (Pelaez, 1976a, 280):
“First, the null hypothesis of no trend was accepted with high confidence; secondly, the null hypothesis of no oscillation was rejected also with high confidence. Consequently, in the nineteenth century international prices of coffee fluctuated but without long-run trend. This statistical fact refutes the extreme argument of structural weakness of the coffee trade.”
The conventional theory that the terms of trade of Brazil deteriorated over the long term is without reality (Pelaez 1976a, 280-281):
“Moreover, physical exports of coffee by Brazil increased at the high average rate of 3.5 per cent per year. Brazil's exchange receipts from coffee-exporting in sterling increased at the average rate of 3.5 per cent per year and receipts in domestic currency at 4.5 per cent per year. Great Britain supplied nearly all the imports of the coffee economy. In the period of the free coffee market, British export prices declined at the rate of 0.5 per cent per year. Thus, the income terms of trade of the coffee economy improved at the relatively satisfactory average rate of 4.0 per cent per year. This is only a lower bound of the rate of improvement of the terms of trade. While the quality of coffee remained relatively constant, the quality of manufactured products improved significantly during the fifty-year period considered. The trade data and the non-parametric tests refute conclusively the long-run hypothesis. The valid historical fact is that the tropical export economy of Brazil experienced an opportunity of absorbing rapidly increasing quantities of manufactures from the "workshop" countries. Therefore, the coffee trade constituted a golden opportunity for modernization in nineteenth-century Brazil.”
Imlah (1958) provides decline of British export prices at 0.5 percent in the nineteenth century and there were no lost decades, depressions or unconventional monetary policies in the highly dynamic economy of England that provided the world’s growth impulse. The experience of the United Kingdom with deflation and economic growth is relevant and rich. Yearly percentage changes of the composite index of prices of the United Kingdom of O’Donoghue and Goulding (2004) provide strong evidence. There are 73 declines of inflation in the 145 years from 1751 to 1896. Prices declined in 50.3 percent of 145 years. Some price declines were quite sharp and many occurred over several years. O’Donoghue and Goulding (2004) also provide inflation data for the UK from 1929 to 1934. Deflation was much sharper in continuous years in earlier periods than during the Great Depression. The United Kingdom could not have led the world in modern economic growth if there were meaningful causality from deflation to depression.
Chart IV-4, US, Consumer Price Index, All Items, NSA, 12-Month Percentage Change 1914-2013
Source: US Bureau of Labor Statistics
Chart IV-5 provides the US consumer price index excluding food and energy from 1957 (when it first becomes available) to 2013. There is long-term inflation in the US without episodes of deflation that would justify symmetric inflation targets to increase inflation from low levels.
Chart IV-5, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2013
Source: US Bureau of Labor Statistics
Chart IV-6 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 (when it first becomes available) to 2013. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.
Chart IV-6, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2013
Source: US Bureau of Labor Statistics
There are waves of inflation of producer prices in France as everywhere in the world economy (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html), as shown in Table IV-6. There was a first wave of sharply increasing inflation in the first four months of 2011 originating in the surge of commodity prices driven by carry trades from zero interest rates to commodity futures risk positions. Producer price inflation in the first four months of 2011 was at the annual equivalent rate of 10.4 percent. In the second wave, producer prices fell 0.2 percent in May and another 0.1 percent in Jun for annual equivalent inflation in May-Jun 2011 of minus 1.8 percent. In the third wave from Jul to Sep 2011, annual equivalent producer price inflation was 3.7 percent. In the fourth wave Oct-Dec 2011, annual equivalent producer price inflation was 2.8 percent. In the fifth wave Jan-Mar 2012, average annual inflation rose to 6.2 percent during carry trades from zero interest rates to commodity futures. In the sixth wave in Apr-Jun 2012, annual equivalent inflation fell at the rate of 4.3 percent during unwinding of carry trades because of increasing risk aversion. In the seventh wave, carry trades returned under more relaxed risk aversion with producer price inflation in France at 7.4 percent in annual equivalent in Jul-Oct 2012. In the eighth wave, return of risk aversion caused unwinding carry trade and annual equivalent inflation of minus 4.1 percent in Nov-Dec 2012. In the ninth wave, inflation returned with annual equivalent 4.9 percent in Jan-Mar 2013. In the tenth wave, annual equivalent inflation was minus 11.0 percent in Apr-Jun 2013. In the eleventh wave, annual equivalent inflation was 8.7 percent in Jul 2013 and 4.9 percent in Jul-Sep 2013. In the twelfth wave, annual equivalent inflation in Oct 2013 was minus 3.5 percent. The bottom part of Table IV-5 shows producer price inflation at 3.2 percent in the 12 months ending in Dec 2005 and again at 4.6 percent in the 12 months ending in Dec 2007. Producer prices fell in 2009 during the global contraction and decline of commodity prices but returned at 4.3 percent in the 12 months ending in Dec 2010.
Table IV-6, France, Producer Price Index for the French Market, ∆%
| Month | 12 Months | |
| Oct 2013 | -0.2 | -1.4 |
| AE ∆% Oct | -3.5 | |
| Sep | 0.4 | -0.6 |
| Aug | 0.1 | -0.7 |
| Jul | 0.7 | 0.2 |
| AE ∆% Jul-Sep | 4.9 | |
| Jun | -0.4 | 0.0 |
| May | -1.2 | -0.2 |
| Apr | -1.3 | 0.4 |
| AE ∆% Apr-Jun | -11.0 | |
| Mar | 0.1 | 1.8 |
| Feb | 0.5 | 2.1 |
| Jan | 0.6 | 2.1 |
| AE ∆% Jan-Mar | 4.9 | |
| Dec 2012 | -0.5 | 2.0 |
| Nov | -0.2 | 2.2 |
| AE ∆% Nov-Dec | -4.1 | |
| Oct | 0.5 | 2.8 |
| Sep | 0.3 | 2.8 |
| Aug | 1.0 | 2.8 |
| Jul | 0.6 | 1.8 |
| AE ∆% Jul-Oct | 7.4 | |
| Jun | -0.6 | 1.8 |
| May | -0.6 | 2.3 |
| Apr | 0.1 | 2.8 |
| AE ∆% Apr-Jun | -4.3 | |
| Mar | 0.5 | 3.6 |
| Feb | 0.5 | 4.0 |
| Jan | 0.5 | 4.2 |
| AE ∆% Jan-Mar | 6.2 | |
| Dec 2011 | -0.2 | 4.5 |
| Nov | 0.4 | 5.2 |
| Oct | 0.5 | 5.3 |
| AE ∆% Oct-Dec | 2.8 | |
| Sep | 0.3 | 5.4 |
| Aug | 0.0 | 5.6 |
| Jul | 0.6 | 5.7 |
| AE ∆% Jul-Sep | 3.7 | |
| Jun | -0.1 | 5.4 |
| May | -0.2 | 5.7 |
| AE ∆% May-Jun | -1.8 | |
| Apr | 1.0 | 6.0 |
| Mar | 0.8 | 5.7 |
| Feb | 0.7 | 5.2 |
| Jan | 0.8 | 4.6 |
| AE ∆% Jan-Apr | 10.4 | |
| Dec 2010 | 4.3 | |
| Dec 2009 | -2.9 | |
| Dec 2008 | 0.8 | |
| Dec 2007 | 4.6 | |
| Dec 2006 | 2.6 | |
| Dec 2005 | 3.2 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20131129
Chart IV-5 of the Institut National de la Statistique et des Études Économiques of France provides the producer price index for the internal market in France from Jan 1999 to Oct 2013. The index also captures the low price environment of the early 2000s that was used as an argument of fear of deflation. For fear of deflation, see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95. During the first round of unconventional monetary policy of low interest rates and withdrawal of duration in bond markets by suspension of auctions of the 30-year Treasury bond, inflation accelerated from 2004 to 2007. When policy interest rates were moved toward zero in 2008, carry trades during a global recession caused sharp increases in commodity prices and price indexes worldwide. Inflation collapsed in the risk panic from the latter part of 2008 into the first part of 2009. Carry trades induced by zero interest rates have caused a trend of inflation with oscillations during period of risk aversion (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html).
Chart IV-5, France, Producer Prices for the Internal Market, Jan 1999-Oct 2013, 2010=100
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20131129
France’s producer price index for the domestic market is shown in Table IV-7 for Oct 2013. The segment of prices of coke and refined petroleum decreased 3.9 percent in Oct 2013 and decreased 10.7 percent in 12 months. Manufacturing prices, with the highest weight in the index, decreased 0.6 percent in Oct and decreased 1.3 percent in 12 months. Mining prices increased 1.1 percent in Oct and decreased 1.6 percent in 12 months. Waves of inflation originating in carry trades from unconventional monetary policy of zero interest rates (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html) tend to deteriorate sales prices of productive activities relative to prices of inputs and commodities with adverse impact on operational margins and thus on production, investment and hiring.
Table IV-7, France, Producer Price Index for the Domestic Market, %
| Oct 2013 | Weight | Month ∆% | 12 Months ∆% |
| Total | 1000 | -0.2 | -1.4 |
| Mining | 226 | 1.1 | -1.6 |
| Mfg | 774 | -0.6 | -1.3 |
| Food Products, Beverages, Tobacco | 196 | -0.8 | 0.6 |
| Coke and Refined Petroleum | 49 | -3.9 | -10.7 |
| Electrical, Electronic | 53 | -0.2 | 0.0 |
| Transport | 80 | -0.2 | 0.1 |
| Other Mfg | 396 | -0.2 | -1.2 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20131129
Chart IV-2 of the Institut National de la Statistique et des Études Économiques of France provides the behavior of the producer price index of France for the various segments: import prices, foreign markets, domestic market and all markets. All the components rose to the peak in 2008 driven by carry trades from zero interest rates of unconventional monetary policy that was of such an impulse as to drive increases in commodity prices during the global recession. Prices collapsed with the flight out of financial risk assets such as commodity positions to government obligations. Commodity price increases returned with zero interest rates and subdued risk aversion. The shock of confidence of the current European sovereign risk moderated exposures to financial risk that influenced the flatter curve of France’s producer prices followed by another mild trend of increase and moderation in Dec 2011 and then renewed inflation in the first quarter of 2012 with a new pause in Apr 2012, decline in May-Jun 2012, the jump in Jul-Oct 2012 and the decline in Nov-Dec 2012 followed by increase in Jan-Feb 2013. Prices stabilized in Mar 2013 and collapsed in Apr-Jun 2013. Inflation returned in Jul 2013 with sharp increase in energy prices and in Aug-Sep 2013. Prices fell in Oct 2013 with reversals of exposures in commodities.
Chart IV-6, France, Producer Price Index (PPI)
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20131129
Italy’s producer price inflation in Table IV-8 also has the same waves in 2011 and into 2012-2013 observed for many countries (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html). The annual equivalent producer price inflation in the first wave Jan-Apr 2011, annual equivalent inflation was 10.7 percent, which was driven by increases in commodity prices resulting from the carry trades from zero interest rates to risk financial assets, in particular leveraged positions in commodities. In the second wave, producer price inflation was 1.8 percent in annual equivalent rate in May-Jun 2011. In the third wave, annual equivalent inflation was 4.9 percent in Jul-Sep 2011. With the return of risk aversion in the fourth wave coinciding with the worsening sovereign debt crisis in Europe, annual equivalent inflation was 2.0 percent in Oct-Dec 2011. Inflation accelerated in the fifth wave in Jan and Feb 2012 to annual equivalent 8.1 percent. In the sixth wave, annual equivalent inflation in Mar-Apr 2012 was at 6.8 percent. In the seventh wave, risk aversion originating in world economic slowdown and financial turbulence softened carry trades with annual equivalent inflation falling to minus 0.6 percent in May-Jun 2012. In the eighth wave, more aggressive carry trades into commodity futures exposures resulted in increase of inflation at annual equivalent 9.4 percent in Jul-Aug 2012. In the ninth wave, risk aversion caused unwinding carry trades with annual equivalent inflation of minus 5.2 percent in Sep 2012-Jan 2013. Inflation returned in the tenth wave at 1.2 percent annual equivalent in Feb-Mar 2013. In the eleventh wave, industrial prices fell at annual equivalent 3.5 percent in Apr-May 2013. In the twelfth wave, inflation returned at annual equivalent 4.9 percent in Jun 2013 and 0.3 percent in Jun-Sep 2013. In the thirteenth wave, annual equivalent inflation was minus 14.5 percent in Oct 2013.
Table IV-8, Italy, Industrial Prices, Internal Market
| Month ∆% | 12-Month ∆% | |
| Oct 2013 | -1.3 | -2.7 |
| AE ∆% Oct | -14.5 | |
| Sep | 0.0 | -2.2 |
| Aug | 0.1 | -2.4 |
| Jul | -0.4 | -1.5 |
| Jun | 0.4 | -0.7 |
| AE ∆% Jun-Sep | 0.3 | |
| May | -0.1 | -1.1 |
| Apr | -0.5 | -1.1 |
| AE ∆% Apr-May | -3.5 | |
| Mar | 0.0 | 0.0 |
| Feb | 0.2 | 0.5 |
| AE ∆% Feb-Mar | 1.2 | |
| Jan | -0.6 | 0.7 |
| Dec 2012 | -0.3 | 2.4 |
| Nov | -0.3 | 2.8 |
| Oct | -0.7 | 3.5 |
| Sep | -0.3 | 4.2 |
| AE ∆% Sep-Jan | -5.2 | |
| Aug | 1.1 | 4.5 |
| Jul | 0.4 | 3.8 |
| AE ∆% Jul-Aug | 9.4 | |
| Jun | 0.0 | 4.2 |
| May | -0.1 | 4.4 |
| AE ∆% May-Jun | -0.6 | |
| Apr | 0.6 | 4.6 |
| Mar | 0.5 | 4.8 |
| AE ∆% Mar-Apr | 6.8 | |
| Feb | 0.5 | 5.2 |
| Jan | 0.8 | 5.2 |
| AE ∆% Jan-Feb | 8.1 | |
| Dec 2011 | 0.1 | 5.5 |
| Nov | 0.4 | 6.0 |
| Oct | 0.0 | 6.1 |
| AE ∆% Oct-Dec | 2.0 | |
| Sep | 0.0 | 5.3 |
| Aug | 0.4 | 5.4 |
| Jul | 0.8 | 5.2 |
| AE ∆% Jul-Sep | 4.9 | |
| Jun | 0.2 | 4.6 |
| May | 0.1 | 4.6 |
| AE ∆% May-Jun | 1.8 | |
| Apr | 0.9 | 5.1 |
| Mar | 0.9 | 5.0 |
| Feb | 0.4 | 4.5 |
| Jan | 1.2 | 5.3 |
| AE ∆% Jan-Apr | 10.7 | |
| Year | ||
| 2012 | 4.2 | |
| 2011 | 5.1 | |
| 2010 | 3.1 | |
| 2009 | -5.4 | |
| 2008 | 5.8 | |
| 2007 | 3.3 | |
| 2006 | 5.3 | |
| 2005 | 4.0 | |
| 2004 | 2.8 | |
| 2003 | 1.6 | |
| 2002 | 0.1 | |
| 2001 | 2.0 |
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/105319
Chart IV-7 of the Istituto Nazionale di Statistica provides 12-month percentage changes of the producer price index of Italy. Rates of change in 12 months stabilized from Jul to Nov 2011 and then fell to 3.5 percent in Jan 2012 with increases of 0.7 percent in the month of Jan 2013 and 0.5 percent in Feb 2013 followed by stability in Mar 2013. Inflation turned negative in Apr-May 2013 with marginal increase in Jun 2013 followed by decline in Jul-Oct 2013.
Chart IV-7, Italy, Producer Price Index 12-Month Percentage Changes
Source: Istituto Nazionale di Statistica
Monthly and 12-month inflation of the producer price index of Italy and individual components is in Table IV-9. Energy prices decreased 3.7 percent in Oct 2013 and fell 7.9 percent in 12 months. Producer-price inflation is minus 0.3 percent for consumer goods and minus 0.3 percent for nondurable goods. There is higher inflation in 12 months of 0.7 percent for nondurable goods than 0.0 percent for durable goods.
Table IV-9, Italy, Industrial Prices, Internal Market, ∆%
| Oct 2013/ | Oct 2013/ | |
| Total | -1.3 | -2.7 |
| Consumer Goods | -0.3 | 0.5 |
| Durable Goods | 0.0 | 0.0 |
| Nondurable | -0.3 | 0.7 |
| Capital Goods | 0.0 | 0.2 |
| Intermediate | -0.1 | -1.0 |
| Energy | -3.7 | -7.9 |
| Total Excluding Energy | -0.1 | -0.3 |
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/105319
The first wave of commodity price increases in the first four months of Jan-Apr 2011 also influenced the surge of consumer price inflation in Italy shown in Table IV-10. Annual equivalent inflation in the first four months of 2011 from Jan to Apr was 4.9 percent. The crisis of confidence or risk aversion resulted in reversal of carry trades on commodity positions. Consumer price inflation in Italy was subdued in the second wave in Jun and May 2011 at 0.1 percent for annual equivalent 1.2 percent. In the third wave in Jul-Sep 2011, annual equivalent inflation increased to 2.4 percent. In the fourth wave, annual equivalent inflation in Oct-Nov 2011 jumped again at 3.0 percent. Inflation returned in the fifth wave from Dec 2011 to Jan 2012 at annual equivalent 4.3 percent. In the sixth wave, annual equivalent inflation rose to 5.7 percent in Feb-Apr 2012. In the seventh wave, annual equivalent inflation was 1.2 percent in May-Jun 2012. In the eighth wave, annual equivalent inflation increased to 3.0 percent in Jul-Aug 2012. In the ninth wave, inflation collapsed to zero in Sep-Oct 2012 and was minus 0.8 percent in annual equivalent in Sep-Nov 2012. In the tenth wave, annual equivalent inflation in Dec 2012 to Aug 2013 was 2.0 percent. In the twelfth wave, annual equivalent inflation was minus 3.5 percent in Sep-Nov 2013 during reallocations of investment portfolios away from commodity futures. There are worldwide shocks to economies by intermittent waves of inflation originating in combination of zero interest rates and quantitative easing with alternation of risk appetite and risk aversion (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html).
Table IV-10, Italy, Consumer Price Index
| Month | 12 Months | |
| Nov 2013 | -0.4 | 0.6 |
| Oct | -0.2 | 0.8 |
| Sep | -0.3 | 0.9 |
| AE ∆% Sep-Nov | -3.5 | |
| Aug | 0.4 | 1.2 |
| Jul | 0.1 | 1.2 |
| Jun | 0.3 | 1.2 |
| May | 0.0 | 1.1 |
| Apr | 0.0 | 1.1 |
| Mar | 0.2 | 1.6 |
| Feb | 0.1 | 1.9 |
| Jan | 0.2 | 2.2 |
| Dec 2012 | 0.2 | 2.3 |
| AE ∆% Dec 2012-Aug 2013 | 2.0 | |
| Nov | -0.2 | 2.5 |
| Oct | 0.0 | 2.6 |
| Sep | 0.0 | 3.2 |
| AE ∆% Sep-Nov | -0.8 | |
| Aug | 0.4 | 3.2 |
| Jul | 0.1 | 3.1 |
| AE ∆% Jul-Aug | 3.0 | |
| June | 0.2 | 3.3 |
| May | 0.0 | 3.2 |
| AE ∆% May-Jun | 1.2 | |
| Apr | 0.5 | 3.3 |
| Mar | 0.5 | 3.3 |
| Feb | 0.4 | 3.3 |
| AE ∆% Feb-Apr | 5.7 | |
| Jan | 0.3 | 3.2 |
| Dec 2011 | 0.4 | 3.3 |
| AE ∆% Dec-Jan | 4.3 | |
| Nov | -0.1 | 3.3 |
| Oct | 0.6 | 3.4 |
| AE ∆% Oct-Nov | 3.0 | |
| Sep | 0.0 | 3.0 |
| Aug | 0.3 | 2.8 |
| Jul | 0.3 | 2.7 |
| AE ∆% Jul-Sep | 2.4 | |
| Jun | 0.1 | 2.7 |
| May | 0.1 | 2.6 |
| AE ∆% May-Jun | 1.2 | |
| Apr | 0.5 | 2.6 |
| Mar | 0.4 | 2.5 |
| Feb | 0.3 | 2.4 |
| Jan | 0.4 | 2.1 |
| AE ∆% Jan-Apr | 4.9 | |
| Dec 2010 | 0.4 | 1.9 |
| Annual | ||
| 2012 | 3.0 | |
| 2011 | 2.8 | |
| 2010 | 1.5 | |
| 2009 | 0.8 | |
| 2008 | 3.3 | |
| 2007 | 1.8 | |
| 2006 | 2.1 |
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/105241
Consumer price inflation in Italy by segments in the estimate by ISTAT for Nov 2013 is provided in Table IV-11. Total consumer price inflation in Nov 2013 was minus 0.4 percent and 0.6 percent in 12 months. Inflation of goods was minus 0.1 percent in Nov 2013 and 0.1 percent in 12 months. Prices of durable goods increased 0.1 percent in Nov and decreased 0.8 percent in 12 months, as typical in most countries. Prices of energy decreased 0.9 percent in Nov and decreased 3.2 percent in 12 months. Food prices increased 0.2 percent in Nov and increased 1.3 percent in 12 months. Prices of services decreased 0.7 percent in Nov and rose 1.2 percent in 12 months. Transport prices, also influenced by commodity prices, decreased 1.0 percent in Nov and increased 2.7 percent in 12 months. Carry trades from zero interest rates to positions in commodity futures cause increases in commodity prices. Waves of inflation originate in periods when there is no risk aversion and commodity prices decline during periods of risk aversion and portfolio reallocations (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html).
Table IV-11, Italy, Consumer Price Index and Segments, Month and 12-Month ∆%
| Nov 2013 | Weights | Month ∆% | 12-Month ∆% |
| General Index | 1,000,000 | -0.4 | 0.6 |
| I Goods | 559,402 | -0.1 | 0.1 |
| Food | 168,499 | 0.2 | 1.3 |
| Energy | 94,758 | -0.9 | -3.2 |
| Durable | 89,934 | 0.1 | -0.8 |
| Nondurable | 71,031 | -0.2 | 1.6 |
| II Services | 440,598 | -0.7 | 1.2 |
| Housing | 71,158 | 0.1 | 2.3 |
| Communications | 20,227 | 0.2 | -8.1 |
| Transport | 81,266 | -1.0 | 2.7 |
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/105241
Chart IV-8 of the Istituto Nazionale di Statistica shows moderation in 12-month percentage changes of the consumer price index of Italy with marginal increase followed by decline to 2.5 percent in Nov 2012, 2.3 percent in Dec 2012, 2.2 percent in Jan 2013, 1.9 percent in Feb 2013 and 1.6 percent in Mar 2013. Consumer prices increased 1.1 percent in the 12 months ending in Apr-May 2013 and 1.2 percent in Jun-Jul 2013. In Aug 2013, consumer prices increased 1.2 percent in 12 months. Consumer prices increased 0.9 percent in the 12 months ending in Sep 2013 and 0.8 percent in the 12 months ending in Oct 2013. Consumer prices increased 0.6 percent in the 12 months ending Nov 2013.
Chart, IV-8, Italy, Consumer Price Index, 12-Month Percentage Changes
Source: Istituto Nazionale di Statistica
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
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